Following the hot start to the first three months of the year — the best since 1998 — U.S. equity markets continued their climb in April before falling materially in May amidst renewed escalation of tariffs and trade wars with multiple U.S. trading partners. Stocks subsequently recovered in June on the expectation that the Federal Reserve will lower rates in the not-too-distant future — which could serve to prolong the current growth cycle. After the dust of the quarter had settled, the S&P 500 Index finished the three-month period up 4.30%, with the Dow Jones up 3.21% and the NASDAQ up 3.87%.
Despite the uptick in trade tensions, international equities also posted positive performance for the quarter. The MSCI EAFE Index, which measures equity market performance in global developed markets (excluding the U.S. and Canada), closed the quarter up 3.68%. The MSCI Emerging Markets Index, which measures equity market performance in 26 emerging market countries, finished up 0.61%.
Fixed income markets also saw increases during the quarter as spreads continued to compress. The Bloomberg Barclays U.S. Aggregate Index ended the most recent three-month period up 3.08%, and the Bloomberg Barclays U.S. High Yield – Corporate Index finished up 2.50%. 10-year U.S. Treasury yields fell during the quarter, with the three-month/10-year yield curve inverting for the second time this year, a historical signal of a pending economic slowdown.
WTI crude oil futures ended the quarter lower at approximately $58/barrel. Rising geopolitical pressures with Iran and renewed threats of a trade war with China were the primary drivers of oil prices this quarter — driving prices down nearly 25% in the middle of the quarter and offsetting production cuts by OPEC+, which were meant to stabilize prices amidst a weakening global economy and increasing U.S. production.
As indicated above, tariffs remained a big headline grabber during the quarter, as trade tensions between China and the U.S. continued to ebb and flow. Negotiations hit a major roadblock in May, as the United States increased tariffs from 10% to 25% on $200 billion of Chinese goods while threatening to add a 25% tariff on nearly all remaining goods shipped from China (approximately $325 billion). In retaliation, China increased tariffs from 5% to 25% on $60 billion of U.S. goods. The quarter ended on a positive note, as the two countries agreed to resume trade negotiations and President Trump eased restrictions on Chinese technology company Huawei. Trade battles weren’t limited to China, however. In a surprise move, President Trump threatened in May to impose new tariffs on Mexico if the country didn’t work to stem the surge of illegal immigrants crossing the border into the U.S. Shortly after issuing the threat, the president walked it back, indicating that the U.S. and Mexico had come to an agreement and tariffs were “indefinitely suspended.” If Mexico’s actions don’t produce desired results, however, the Trump administration could quickly put tariffs back on the table.
At each of the meetings that occurred during the second quarter, the Fed kept the Fed Funds rate unchanged at a range of 2.25% to 2.50%. While the central bank continues to promote a more patient, data-dependent approach to monetary policy, several Fed officials believe the case for accommodation has strengthened in recent months. The Fed has not yet announced a formal plan to cut rates, but Chairman Powell stated during the quarter that the central bank will act as appropriate to sustain economic expansion, strong labor markets and inflation near 2%. To that extent, the market now expects multiple rate cuts by the end of 2019 — the first of which could occur as early as July — with investors betting these cuts will drive stocks higher and extend the decade-long bull market.
Jobs continued to be added to the U.S. economy in the second quarter, with May marking 104 consecutive months of jobs gains and April and June posting greater-than-expected employment growth. Moreover, the unemployment rate remained at a near 50-year low of 3.7% in June, while wage growth was steady at 3.1% year-over-year. Despite positive employment figures, we are concerned by recent data that suggests a slowing U.S. economy. Additionally, analysts now expect corporate earnings to decline by more than 2% in the second quarter, which would mark two consecutive quarters of year-over-year earnings declines. Such slowdowns in GDP and earnings are indicative of a late cycle economy and a bull market that may be peaking.
Through the first half of 2019, the bull market thesis has been buoyed by four pillars: (1) The Fed will support the markets with a pre-emptive rate cut in the near future; (2) the U.S. and China will reach a mutually beneficial trade agreement; (3) corporate earnings will recover in response to continued economic expansion; and (4) interest rates will stabilize as the yield curve returns to a more normal slope. All four of these pillars have been violated and/or appropriately questioned at some point over the past few months, supporting our belief that the market’s headwinds outweigh the tailwinds and stocks are not appropriately priced for the potential risks. More importantly, the bull market thesis today is heavily reliant on the belief that the Fed will cut interest rates multiple times this year. Any signal from Fed officials that they are not as willing to cut rates as expected is likely to result in a sell-off in risky assets. As a result, our outlook remains one of caution, as we think it is likely that a correction could occur at some point this year. During times of uncertainty, it is important that investors are appropriately diversified and remain committed to their long-term investing strategy. GuideStone strives to identify opportunities and risks in financial markets and is well-positioned to make opportunistic moves within the Funds in anticipation of, or in response to, specific market events or changing market conditions. As always, we do not recommend trying to time the market.
Thank you for your confidence in GuideStone. Please feel free to contact us if you have any comments, questions or concerns.